The Euro and European Prices

Among the hoped-for effects of the Euro's physical arrival are an increased transparency of the differences in retail prices between different EMU countries, and a subsequent pressure to equalize these prices. The argument for the latter is simple: with national currencies eliminated and everything priced in Euros, how can similar cars or loaves of bread have different prices on either side of a border? Pressures will be formidable to buy where prices are low and sell, or at least not to buy, where prices are high.

That argument, however, is naive, for it does not take a genius to compare the price of a car in Germany with the price of the same car in France. Everybody makes such calculations when they decide where to take vacations abroad, so why believe that they do not do it for other goods and services? People are not as stupid or lazy as politicians and bureaucrats think. The interesting question is this: how much are price discrepancies due to sheer ignorance and inertia, and how much are they due to factors that are unlikely to change with the Euro's arrival?

Start with the evidence on retail prices. UBS, the Swiss banking group, prices a standard basket of 111 goods and services in various cities around the world. For European cities, the results are listed in the table below, which uses Germany as the benchmark. Obviously, huge price differences exist- if people in Finland were to do their shopping in Spain, they would increase their purchasing power by 50%! So, if price equalization were to happen, citizens in rich countries would feast and those in poorer countries would pay through the nose. But that won't happen; price level differences will not change much, the Euro notwithstanding.

The UBS survey shows that prices in Frankfurt are 8% higher than in Berlin. Prices in Houston, Texas (to use prices in a similar unitary monetary area, the US) are 26% less than in NY, and somewhat less than in Los Angeles. Both differences matter because they show that price equalization does not occur simply because a common currency exists.

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